December 08, 2007

Justin Fox on Arthur Laffer and Company

A nice piece by Justin Fox that informs his readers:

Tax Cuts Don't Boost Revenues: Virtually every economics Ph.D. who has worked in the Bush Administration acknowledges that the tax cuts of the past six years haven't paid for themselves. If there's one thing that Republican politicians agree on, it's that slashing taxes brings the government more money.... President Bush... Vice President Dick Cheney... John McCain... Rudy Giuliani.... If there's one thing that economists agree on, it's that these claims are false. We're not talking just ivory-tower lefties. Virtually every economics Ph.D. who has worked in a prominent role in the Bush Administration.... The yawning chasm between Republican rhetoric on taxes and even informed conservative opinion is maddening to those of wonkish bent. Pointing it out has become an opinion-column staple. But none of these screeds seem to have altered the political debate. So rather than write yet another, I decided to find out what Arthur Laffer thought....

About the best I could get out of him on the question of whether the Bush tax cuts have paid for themselves was "I don't know." But that's only part of the story....

The idea that high tax rates brought diminishing returns was not controversial or even new--Laffer traces it to 14th century Muslim philosopher Ibn Khaldun.... Laffer is convinced that the reduction of the top tax rate from 70% to 28% during the Reagan years paid for itself--in part by encouraging the rich to stop finagling--and the evidence mostly backs him up. "You find these enormous responses in the upper brackets," Laffer says. "These guys fire their lawyers and accountants and actually pay their taxes. Yay! Isn't that what we want them to do?"

But Reagan's tax cuts for the nonrich were big money losers, and it took the fiscal discipline of Bill Clinton to mop up the resulting red ink. Laffer gushes with praise for Clinton, but he's also a fan of Clinton's successor. "What Clinton did was, he gave Bush the fiscal flexibility to do what was right," Laffer says. In the face of the recession and terrorist attacks of 2001, Bush "needed to stimulate the economy and spend for defense, and Clinton gave him the ability to do that."

In other words, the Bush tax cuts were meant to create big deficits. But Laffer's O.K. with that. "The Laffer Curve should not be the reason you raise or lower taxes," he says. Perhaps not, but it does make for great campaign promises...

Now, will the press make the connection between the willingness to make these claims and character? Those who say this are either making claims they know are false, or have economic advisors who don't know what they are talking about. In any case, whether its the willingness to mislead to promote an idea, or the incompetence in choosing advisors and the unwillingness to consider evidence at odds with their preconceived notions, it's worth noting. My own view is that their economic advisors know what the evidence really says, and the candidates are choosing to ignore what they are told. But a simple question, "Have your economic advisors informed you that there's no basis for that claim, and if so, why are you making it anyway" or something like that, would tell us the answer. It's not as though this is unimportant, the difference between the claim that the most recent tax cuts are self-financing and the actual evidence is hundreds of billions of dollars and it would seem that with so much at stake, we would hear more about those who mislead us about the true cost of the policies they advocate.

Indeed, even the Washington Post editorial page tries to do the right thing in this instance:

Mr. Giuliani and the Tax Fairy: "I KNOW THAT reducing taxes produces more revenues," Republican presidential candidate Rudolph Giuliani declares in a new television ad launched Thursday. "Democrats don't know that. They don't believe it." There's a good reason for that: It's not true. Produces more revenue than what? Than if taxes had not been cut? No -- and no matter how many times Republican politicians caught up in the thrill of supply-side thinking pronounce that tax cuts pay for themselves, they cannot will it to be correct....

President Bush's Treasury Department... found... the positive economic impact would make up for no more than 10 percent of the tax cuts' cost. "I certainly would not claim that tax cuts pay for themselves," Edward P. Lazear, chairman of the president's Council of Economic Advisers, testified.... N. Gregory Mankiw, another former Council of Economic Advisers head in the Bush White House, concluded in 2005 that cuts on capital gains taxes could generate enough extra growth to recoup half the lost revenue in the long run; cutting taxes on wages could recover just 17 percent of the costs.... CBO under Douglas Holtz-Eakin... under the rosiest of scenarios... 22 percent of lost revenue in the first five years and 32 percent in the second five.

Mr. Giuliani isn't the only believer in the tax fairy; numerous Republicans, including the president, have made similarly fanciful claims. But if he were to find himself in the White House and hoping to find that extra revenue he is convinced tax cuts produce, Mr. Giuliani would discover only disappointment under the presidential pillow.

Two things wrong with the Post, however. First, a lot of punches are pulled in the editorial--it's an anti-Giuliani editorial, but it is not a Giuliani-only doctrine: it is one he shares with every other senior Republican including all the other presidential candidates. Punching only Giuliani is... odd, at best.

Second, the right capital gains revenue replacement number to quote from the base case considered by Mankiw-Weinzerl http://www.nber.org/papers/w11000 is not 50% but 33%, and applies only if all the revenue lost through the tax cut is neutralized by accompanying spending cuts: cut capital gains taxes and leave spending unchanged and you will find yourself losing more rather than less than 100% of the static revenue loss in short order. (Moreover, a strictly forward-looking investment tax credit dominates a largely backward-looking capital gains tax cut.)

UPDATE: As I read the evidence, Arthur Laffer is probably right at the top end: reducing the top tax rate from 70% to 50% is probably a revenue gainer and surely not much of a loser. From 50% to 28% is, I think, very different: a big revenue loser.

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Justin Fox on Arthur Laffer and Company

A nice piece by Justin Fox that informs his readers:

Tax Cuts Don't Boost Revenues: Virtually every economics Ph.D. who has worked in the Bush Administration acknowledges that the tax cuts of the past six years haven't paid for themselves. If there's one thing that Republican politicians agree on, it's that slashing taxes brings the government more money.... President Bush... Vice President Dick Cheney... John McCain... Rudy Giuliani.... If there's one thing that economists agree on, it's that these claims are false. We're not talking just ivory-tower lefties. Virtually every economics Ph.D. who has worked in a prominent role in the Bush Administration.... The yawning chasm between Republican rhetoric on taxes and even informed conservative opinion is maddening to those of wonkish bent. Pointing it out has become an opinion-column staple. But none of these screeds seem to have altered the political debate. So rather than write yet another, I decided to find out what Arthur Laffer thought....

About the best I could get out of him on the question of whether the Bush tax cuts have paid for themselves was "I don't know." But that's only part of the story....

The idea that high tax rates brought diminishing returns was not controversial or even new--Laffer traces it to 14th century Muslim philosopher Ibn Khaldun.... Laffer is convinced that the reduction of the top tax rate from 70% to 28% during the Reagan years paid for itself--in part by encouraging the rich to stop finagling--and the evidence mostly backs him up. "You find these enormous responses in the upper brackets," Laffer says. "These guys fire their lawyers and accountants and actually pay their taxes. Yay! Isn't that what we want them to do?"

But Reagan's tax cuts for the nonrich were big money losers, and it took the fiscal discipline of Bill Clinton to mop up the resulting red ink. Laffer gushes with praise for Clinton, but he's also a fan of Clinton's successor. "What Clinton did was, he gave Bush the fiscal flexibility to do what was right," Laffer says. In the face of the recession and terrorist attacks of 2001, Bush "needed to stimulate the economy and spend for defense, and Clinton gave him the ability to do that."

In other words, the Bush tax cuts were meant to create big deficits. But Laffer's O.K. with that. "The Laffer Curve should not be the reason you raise or lower taxes," he says. Perhaps not, but it does make for great campaign promises...

Now, will the press make the connection between the willingness to make these claims and character? Those who say this are either making claims they know are false, or have economic advisors who don't know what they are talking about. In any case, whether its the willingness to mislead to promote an idea, or the incompetence in choosing advisors and the unwillingness to consider evidence at odds with their preconceived notions, it's worth noting. My own view is that their economic advisors know what the evidence really says, and the candidates are choosing to ignore what they are told. But a simple question, "Have your economic advisors informed you that there's no basis for that claim, and if so, why are you making it anyway" or something like that, would tell us the answer. It's not as though this is unimportant, the difference between the claim that the most recent tax cuts are self-financing and the actual evidence is hundreds of billions of dollars and it would seem that with so much at stake, we would hear more about those who mislead us about the true cost of the policies they advocate.

Indeed, even the Washington Post editorial page tries to do the right thing in this instance:

Mr. Giuliani and the Tax Fairy: "I KNOW THAT reducing taxes produces more revenues," Republican presidential candidate Rudolph Giuliani declares in a new television ad launched Thursday. "Democrats don't know that. They don't believe it." There's a good reason for that: It's not true. Produces more revenue than what? Than if taxes had not been cut? No -- and no matter how many times Republican politicians caught up in the thrill of supply-side thinking pronounce that tax cuts pay for themselves, they cannot will it to be correct....

President Bush's Treasury Department... found... the positive economic impact would make up for no more than 10 percent of the tax cuts' cost. "I certainly would not claim that tax cuts pay for themselves," Edward P. Lazear, chairman of the president's Council of Economic Advisers, testified.... N. Gregory Mankiw, another former Council of Economic Advisers head in the Bush White House, concluded in 2005 that cuts on capital gains taxes could generate enough extra growth to recoup half the lost revenue in the long run; cutting taxes on wages could recover just 17 percent of the costs.... CBO under Douglas Holtz-Eakin... under the rosiest of scenarios... 22 percent of lost revenue in the first five years and 32 percent in the second five.

Mr. Giuliani isn't the only believer in the tax fairy; numerous Republicans, including the president, have made similarly fanciful claims. But if he were to find himself in the White House and hoping to find that extra revenue he is convinced tax cuts produce, Mr. Giuliani would discover only disappointment under the presidential pillow.

Two things wrong with the Post, however. First, a lot of punches are pulled in the editorial--it's an anti-Giuliani editorial, but it is not a Giuliani-only doctrine: it is one he shares with every other senior Republican including all the other presidential candidates. Punching only Giuliani is... odd, at best.

Second, the right capital gains revenue replacement number to quote from the base case considered by Mankiw-Weinzerl http://www.nber.org/papers/w11000 is not 50% but 33%, and applies only if all the revenue lost through the tax cut is neutralized by accompanying spending cuts: cut capital gains taxes and leave spending unchanged and you will find yourself losing more rather than less than 100% of the static revenue loss in short order. (Moreover, a strictly forward-looking investment tax credit dominates a largely backward-looking capital gains tax cut.)

UPDATE: As I read the evidence, Arthur Laffer is probably right at the top end: reducing the top tax rate from 70% to 50% is probably a revenue gainer and surely not much of a loser. From 50% to 28% is, I think, very different: a big revenue loser.